Ecografía del segundo y tercer trimestre de gestación

As seen in earlier section, forward/futures contract is a commitment to buy/sell the underlying and has a linear pay off, which indicates unlimited losses and profits. Some market participants desired to ride upside and restrict the losses. Accordingly, options emerged as a financial instrument, which restricted the losses with a provision of unlimited profits on buy or sell of underlying asset.

An Option is a contract that gives the right, but not an obligation, to buy or sell the underlying asset on or before a stated date/day, at a stated price, for a price. The party taking a long position i.e. buying the option is called buyer/ holder of the option and the party taking a short position i.e. selling the option is called the seller/ writer of the option.

The option buyer has the right but no obligation with regards to buying or selling the underlying asset, while the option writer has the obligation in the contract. Therefore, option buyer/ holder will exercise his option only when the situation is favourable to him, but, when he decides to exercise, option writer would be legally bound to honour the contract.

Options may be categorized into two main types:-

 Call Options

 Put Options

Option, which gives buyer a right to buy the underlying asset, is called Call option and the option which gives buyer a right to sell the underlying asset, is called Put option. Option terminology

There are several terms used in the options market. Let us comprehend on each of them with the help of the following price:

Quote for Nifty Call option as on September 17, 2015 1. Instrument type : Option Index

2. Underlying asset : Nifty

3. Expiry date : September 24, 2015 4. Option type : Call European 5. Strike Price : 8,000

LEARNING OBJECTIVES:

After studying this chapter, you should know about:

 Concept of Options

 Payoffs in case of option contracts

 Fundamentals relating to option pricing

 Option Greeks

50 6. Open price : 68.00

7. High price : 78.00 8. Low price : 58.65 9. Close price : 71.70

10. Traded Volume : 6,59,304 contracts 11. Open Interest : 43,58,775

12. Underlying value : 7,899.15

Quote for Nifty Put option as on September 17, 2015 1. Instrument type : Option Index

2. Underlying asset : Nifty

3. Expiry date : September 24, 2015 4. Option type : Put European 5. Strike Price : 8000

6. Open price : 190.00 7. High price : 205.75 8. Low price : 157.00 9. Close price : 174.80

10. Traded Volume : 85,027 contracts 11. Open Interest : 30,47,325 12. Underlying value : 7,899.15

Index option: These options have index as the underlying asset. For example options on Nifty, Sensex, etc.

Stock option: These options have individual stocks as the underlying asset. For example, option on ONGC, NTPC etc.

Buyer of an option: The buyer of an option is one who has a right but not the obligation in the contract. For owning this right, he pays a price to the seller of this right called ‘option premium’ to the option seller.

Writer of an option: The writer of an option is one who receives the option premium and is thereby obliged to sell/buy the asset if the buyer of option exercises his right. American option: The owner of such option can exercise his right at any time on or before the expiry date/day of the contract.

European option: The owner of such option can exercise his right only on the expiry date/day of the contract. In India, Index options are European.

Option price/Premium: It is the price which the option buyer pays to the option seller. In our examples, option price for call option is Rs. 71.70 and for put option is Rs. 174.80. Premium traded is for single unit of nifty and to arrive at the total premium in a contract, we need to multiply this premium with the lot size.

Lot size: Lot size is the number of units of underlying asset in a contract. Lot size of Nifty option contracts is 75. Accordingly, in our examples, total premium for call option

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contract would be Rs. 71.70 x 75 = 5.377.50 and total premium for put option contract would be Rs. 174.80 x 75 = 13,110.

Expiration Day: The day on which a derivative contract ceases to exist. It is the last trading date/day of the contract. In our example, the expiration day of contracts is the last Thursday of September month i.e. 24 September, 2015.

Spot price (S): It is the price at which the underlying asset trades in the spot market. In our examples, it is the value of underlying viz. 7,899.15.

Strike price or Exercise price (X): Strike price is the price per share for which the underlying security may be purchased or sold by the option holder. In our examples, strike price for both call and put options is 8000.

In the money (ITM) option: This option would give holder a positive cash flow, if it were exercised immediately. A call option is said to be ITM, when spot price is higher than strike price. And, a put option is said to be ITM when spot price is lower than strike price. In our examples, call option is in the money.

At the money (ATM) option: At the money option would lead to zero cash flow if it were exercised immediately. Therefore, for both call and put ATM options, strike price is equal to spot price.

Out of the money (OTM) option: Out of the money option is one with strike price worse than the spot price for the holder of option. In other words, this option would give the holder a negative cash flow if it were exercised immediately. A call option is said to be OTM, when spot price is lower than strike price. And a put option is said to be OTM when spot price is higher than strike price. In our examples, put option is out of the money.

Intrinsic value: Option premium, defined above, consists of two components - intrinsic value and time value.

For an option, intrinsic value refers to the amount by which option is in the money i.e. the amount an option buyer will realize, before adjusting for premium paid, if he exercises the option instantly. Therefore, only in-the-money options have intrinsic value whereas at-the-money and out-of-the-money options have zero intrinsic value. The intrinsic value of an option can never be negative.

Thus, for call option which is in-the-money, intrinsic value is the excess of spot price (S) over the exercise price (X). Thus, intrinsic value of call option can be calculated as S-X, with minimum value possible as zero because no one would like to exercise his right under no advantage condition.

Similarly, for put option which is in-the-money, intrinsic value is the excess of exercise price (X) over the spot price (S). Thus, intrinsic value of put option can be calculated as X-S, with minimum value possible as zero.

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Time value: It is the difference between premium and intrinsic value, if any, of an option. ATM and OTM options will have only time value because the intrinsic value of such options is zero.

Open Interest: As discussed in futures section, open interest is the total number of option contracts outstanding for an underlying asset.

Exercise of Options

In case of American option, buyers can exercise their option any time before the maturity of contract. All these options are exercised with respect to the settlement value/ closing price of the stock on the day of exercise of option.

Assignment of Options

Assignment of options means the allocation of exercised options to one or more option sellers. The issue of assignment of options arises only in case of American options because a buyer can exercise his options at any point of time.